CURRENCY TRADING

Not For Much Longer

02/11/08 02:31:27 PMby Koos van der MerwePreviously, peanut farmer Jimmy Carter had been regarded by some as the worst US President. Not for much longer.

Security:UDX,,CUCDXPosition:Accumulate

In the late 1970s, President Jimmy Carter was blamed for the high inflation rate in the US, and voters expressed their anger by not reelecting him in 1980. Paul Volcker, the chairman of the Board of Governors of the Federal Reserve System, was credited as having placed the United States back on a sound footing economically, giving the presidents who followed a successful economy until recently with the start of the Iraq war with its huge costs, the subprime crisis being the icing on the cake.

Over this period the US dollar has fallen dramatically as shown by the monthly chart of the US Dollar Index.

FIGURE 1: US DOLLAR INDEX, MONTHLY. See how the index fell from a high of 121.25 to the current low, a drop of 38.86% in seven years.

Figure 1 shows how the US Dollar Index fell from a high of 121.25 on January 31, 2001, to the current low of 74.13, a drop of 38.86% in seven years. With these figures two thoughts immediately come to mind:

a. The 38.86% drop is close enough to the Fibonacci level of 38.2% to be significant as a turning point.b. WD Gann believed that a trend followed a 7-3-7-3 pattern. This means that now that we have seen a seven-year decline in the US Dollar Index, we should see a three-year recovery, starting from 2008, finishing in 2011.

Will there be a further seven-year decline from 2011 to 2018? That at the moment is anyone's guess, but common sense dictates otherwise because were this to occur, the US dollar would become valueless. There is talk at present of the US dollar being supplanted either by the euro or a basket of Asian currencies as the world's basic currency but so far this is just idle chatter by economists, who as we all know have two hands. What should also be remembered is that the dates I have given coincide with the US Presidential cycle, with 2011 as the third term of office and 2012 being the start of a new Presidential cycle. The chairman of the Fed is independent of the President, of course, and is expected to act independently of the President, but this is not necessarily so. Wars cost money. Banks, the holders of a country's wealth, have over the years become financial institutions onto themselves. They create financial products, and the banks' financial advisors then sell those products to investors who have placed their trust in the hands of the banks. They are also risktakers with bank (investor) capital, as many banking crises (the latest one in France) has shown us.

So what now for the US dollar? The weakness of the dollar appears to be approaching an end. Nowhere can this be better seen than when we look at the Canadian dollar. Why the Canadian dollar and not the Australian dollar, New Zealand dollar, or any of the Asian currencies? Asian currencies are becoming more and more linked to the Chinese yuan, which as we all know is not a floating currency. Canada is inexorably linked to the United States, its largest trading partner. However, the Canadian dollar does float and was allowed to appreciate against a falling US dollar to the extent where industries in Canada are starting to suffer as prices of their manufactured goods are become less price-competitive.

FIGURE 2: CANADIAN DOLLAR INDEX, WEEKLY VS. US DOLLAR INDEX. Here's a comparison of the Canadian dollar to the US dollar.

Figure 2 is a weekly chart (inverted) of the Canadian dollar and suggests that the loonie will strengthen further against the US dollar for the short-term. This is confirmed by the stochastic indicator, which is oversold and showing strength. This is contrary to the US dollar index shown, which is looking for support at present levels, although a drop to 67.77 is yet possible. The green trendline drawn on the Canadian dollar chart does suggest a higher target based on time for the loonie -- the further out the time, the stronger the Canadian dollar.

So is President George Bush leaving a legacy where historians will say "the worst President the United States has ever had"? Unlike President Carter, though, President Bush has served two terms. Will the next President be elected to only a four-year term, with the President to follow being the one to clean up the financial mess the United States is currently suffering? The charts seem to think so.

Whatever the outcome, the US Dollar Index does appear to be looking for a bottom. Any weakness in the future stock market that occurs does offer an opportunity to buy US assets at low prices in itself, causing the US dollar to strengthen. However, a negative is that with interest rates in the United States as low as they are, and possibly dropping further in the months ahead as Fed chairman Ben Bernanke shores up a recessionary economy, the US dollar is the currency that could become the brunt of the carry trade -- sell at low interest rates and use the funds to purchase another currency at a higher interest rate.

We must remember, however, that the trader must borrow the US dollar first before they can convert it to the other currency with which to buy a higher interest-bearing bond. This strategy will start the trend toward a stronger US dollar, so those playing the US currency carry trade should beware -- as charts are saying, "Not for much longer."

Koos van der Merwe

Has been a technical analyst since 1969, and has worked as a futures and options trader with First Financial Futures in Johannesburg, South Africa.